Newsletter Vol. 1, No. 1 September 1997

There was no TRA '97 change for this topic, but a reminder is needed. Deferred compensation for executives of tax-exempt ogranizations is subject to very different rules than deferred compensation for business corporation executives. Personnel from the business community, especially those who become directors of trade associations, charities and other tax-exempt organizations need to be briefed on the differences.

Deferred compensation is taxed to business corporation executives when it is paid (and the employer takes its deduction at that time). Thus, business corporation's promise to pay an annuity beginning at age 65 is taxable as monthly payments are received. However, defered compensation for executives of tax-exempt organization is subject to the very restrictive rules of 457(f), which taxes such compensation when earned (the technical phrase is when there is no substantial risk of forfeiture), rather than when paid. Thus, the tax-exempt organization's promise to pay anannuity beginning at age 65 is taxable when the executive has a vested right to the annuity -- at a time substantially before payments ever begin. This treatment applies both to compensation deferred at the election of the executive from current salary and bonuses, and to benefits, supplementing the amounts that can be provided under in the organization's qualified or 403(b) plan.

Exceptions are provided for bona fide severance plans, death benefit plans and vacation pay plans - but none of the exceptions are defined in the legislation and no interpretative regulations have been issues.

The result is that deferred compensation programs routinely used by taxable employers produce undesireable results in the tax-exempt area.

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